As Facebook Continues Testing Credits, Some Developers Worry About Costs

As Facebook continues to experiment with its universal virtual currency, Credits, some developers continue to tell us that the product is going to lose them money — even as others say the opposite.

One issue is the flat 30% fee that Facebook takes from all Credits transactions on third party applications. But there other potential costs, that some in the industry say increases the total percentage to around 50% of their revenue, versus what they are bringing in now.

Facebook, however, believes that Credits will be a net win for developers, and not just a big new revenue stream for itself. Before we get into the details of what the real costs (and benefits) of Credits might be, here’s some more background.

The Place for Credits

The virtual goods market has boomed around the world in the past decade, mainly in Asia — but Facebook quickly becoming a leading platform for growth of companies based on the virtual goods model after it launched its developer platform in late May of 2007. Many people who use third party social games and applications, it turns out, are willing to pay for digital products in order to do things like win a competitive game or more beautifully decorate a virtual space.

This year, we expect the virtual goods revenue model in social games to bring in around $835 million within the US alone, with most of the money coming from Facebook apps. See our Inside Virtual Goods report for more research on the market.

For most of the history of the platform, Facebook has not taken any fee from developers on its platform. When it launched the platform, the company even told developers that they would be able to keep all of the revenue they generated from applications.

Most developers have built their own virtual currencies within their apps, that users can buy using credit cards or through a service like PayPal or earn through offers then use the currency to buy the goods. In many cases, apps will have one currency that users can buy, and another currency that users earn through taking actions within a game, like weeding a crop patch in FarmVille, cleaning the fishbowl in Happy Aquarium, etc.

Credits, in Facebook’s view, will somehow take a central role in this new ecosystem. The company said in April that “there’s just going to be one currency that people use” on Facebook — meaning Credits. It more recently said that it hasn’t decided if Credits will replace other options to be the only currency. At this point, one can observe a variety of Credits implementations in third party apps, from exclusive Credits usage within Crowdstar’s games, to Credits as one of several currency purchasing options in Zynga’s hit game, FarmVille.

The Cost of Credits

Some developers, as we have been chronicling for manymonths, either do not believe that Credits can actually make them more money, ever, or else do not believe that the long-term benefit is worth the near-term costs. Their main line of criticism now is that non-obvious costs that are adding up — especially if Facebook decides to exclude other currencies. Here are the main issues:

Breakage: This industry term means that users pay for an amount of virtual money, but abandon it after a period of time, and thereby forfeit it to the company — outside of Facebook, this often happens with unredeemed gift cards, for example. On Facebook, users will sometimes purchase currency within an app but then, for whatever reason, never use it to buy virtual goods. This form of breakage can account for up to 25% of revenue in some applications, according to industry sources.

Laws covering breakage differ between states and countries. For breakage on Credits itself, Facebook follows California law: If a user doesn’t access their account for three years, the company forfeits the money to the state, per its Unclaimed Property Law (which is based on the common law doctrine of escheating). Developers, especially those based elsewhere, may account for breakage differently, per the state and national laws where they are based. They may, for example, count the initial purchase of virtual currency as revenue, and — entirely within the law — keep the breakage for themselves.

The concern here is that Credits, if somehow mandatory, would replace the currency that users buy but don’t spend, thereby removing this revenue from developers’ balance sheets. Given the uncertainty around how Credits will eventually be implemented, the actual cost to developers is currently unknown.

Loss of Control: The significance of this problem — which one source refers to as “the lack of ability to optimize” a given app — is even less easy to quantify than breakage, although still very real for some developers.

Here’s the concept: By carefully controlling the price and volume of currency in an app, a developer can get more people spending more money, not unlike how central governments control currency supplies in the real world.

For example, games will often promote their virtual currency through special incentives, like deals to buy currency in bulk, at discounts, on a certain day. Or they might introduce new actions into a game that put more virtual currency into the app economy.

So if Facebook mandates Credits and sets a single dollar value for all apps ($0.10 per Credit), developers can no longer use these techniques as they see fit. Again, the issue here assumes that Facebook would make Credits the only currency available, which may not prove to be the case.

Note: Facebook itself is testing the sale of Credits in bulk discounts. Some users are seeing the following, for example: $5.00 for 50 Credits, $10.00 for 105 Credits, or $20.00 for 240 Credits. It is essentially using the same technique as developers, but its goal is to get more Credits into the system; it is footing the bill for the discount, itself, as developers are still getting paid 70% of all Credits transactions in their apps.

A final point here is that, as with breakage, adjusting the value of the currency can be a meaningful way to make more money, but it is not the core mechanic making the revenue stream work. In other words, loss of control may result in lost money, but Credits may also be worth that cost.

Loss of Virality, Rising Ad Prices: Due to a variety changes Facebook has made to its platform over the last half a year or so, many developers are seeing traffic losses. Some are propping themselves up through advertising, but this traffic source has also gotten more expensive due to more advertisers bidding for the most valuable demographics.

However, some apps continue to gain new users despite the changes. And, Facebook is also trying to improve virality on the platform for the long term, now making improvements like adding a bookmarks tab to canvas pages. Overall, user acquisition has become significantly more expensive on Facebook in recent months, according to many developers.

Rumors about Other Issues: As has always been the case on Facebook’s platform, unsubstantiated rumors are also circling. One is that Facebook is charging additional, hidden fees for Credits — many credible industry sources have told us that this is not the case, though. Another rumor is that some developers are getting special deals to mitigate the costs of Credits. Zynga, the largest social game developer, agreed to commit long-term to the platform last month — some believe that this was in exchange for a discount on Facebook advertising, or a similar cost-saving technique, or higher limits to its communication channel allocation limits.

The Case for Credits

To be clear, the negative sentiments here are not unanimous. A recent Wall Street Journal article quoted several well-known companies extolling the currency’s benefits, with Playfish, CrowdStar, PopCap Games and Arkadium saying they are seeing “positive results.” CrowdStar, Facebook’s official Credits test partner, claims that sales of its virtual goods have doubled after it made Credits the only currency in its games. Arkadium told the Journal that Credits users are three times more likely to buy goods versus those who used other options.

Yet other factors could have influenced CrowdStar’s results, like iterative improvements to game mechanics; Arkadium, meanwhile, features Credits more prominently than other payment options.

The real question is what it has been for months. Can Facebook execute on its plans without fundamentally damaging the platform? We’ve heard that the costs for developers do add up to around 50%, given all the factors.

Despite some developers’ negativity, here are the benefits of what Credits will eventually provide, as Facebook explains: better security, more payment options, a simpler user interface, and a range of smaller incentives and promotions. (Read more details on our recent Inside Facebook Gold report on Credits). Right now, only 1% to 3% of users buy virtual goods in the average social game. The company thinks Credits can help developers bring that number far higher, as high as 20%. If it can in fact grow developers’ overall revenue by substantial margins over today’s numbers, developers themselves will make more than than they have been, despite any of the additional costs.

We believe some of the skepticism is due to developers seeing the costs now without getting most of the benefits yet. However, the lack of clarity on Facebook’s part also makes developers more cautious about the company’s ability to bring about the change it envisions.

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